Given HCL’s margin outlook, the gap in valuations of its shares vis-à-vis peers could sustain
HCL Technologies Ltd’s December quarter earnings performance was a mixed bag. Its fastest revenue growth in many years came with uninspiring margin performance. In constant currency terms, revenue grew 7.6% sequentially, driven by a sharp rebound in its products and platforms vertical and spillover of deals from the September quarter. In a conference call with analysts, HCL’s management said fiscal third-quarter revenue growth was the highest in the past 47 quarters.
What is more, last quarter, HCL signed eight large services and as many product deals spanning financial, technology and healthcare services. At the end of December, the total value contract of its new deals was $2.1 billion, an increase of 64% from a year ago. The management said the company’s deal pipeline is strong and broad-based across markets and verticals. So, it is unsurprising that HCL has retained its double-digit revenue growth guidance for FY22.
Note that the third-quarter sequential revenue growth in constant currency of Infosys Ltd, Tata Consultancy Services Ltd (TCS) and Wipro Ltd was 7%, 4%, and 3%, respectively. While HCL’s outperformance on this parameter is heartening, the margin show was underwhelming. Ebit (earnings before interest and tax) margin at 19% was flat compared with the preceding three months, lower than the consensus estimate of 19.4%.
The management indicated that margins in its key revenue generator —the IT Services business segment— declined about 2 percentage points quarter-on-quarter from 18.9% to 17%. Analysts said factors such as costs on salary increment, retention and recruitment, and transition weighed on margins. HCL’s management said it expects margins to be under pressure for the next few quarters. For FY22, the Ebit margin could be at the lower end of the margin guidance of 19-21%. “The margin outlook on IT Services was below estimate as HCL struggles to absorb the impact of an adverse supply scenario. While it will be raising prices across accounts, we expect the margin to stay at the lower end of its current guidance for FY23 before recovering in FY24," analysts at Motilal Oswal Financial Services Ltd said in a report.
To be sure, shares of HCL trade at a discount to peers. Bloomberg data shows the stock trades at 23.5 times FY23 estimated earnings compared with Infosys (30.5 times), TCS (32.9 times), and Wipro (25.4 times). As such, given HCL’s margin outlook, the gap in valuations of its shares vis-à-vis peers can be expected to sustain.